Turkey raises benchmark rate by 625 basis points

Models present creations by Mehtap Elaidi during the Mercedes-Benz Fashion Week in Istanbul, Turkey, on Wednesday.

Photo: EPA-EFE

Local investors’ reaction to a Turkish interest-rate hike suggests that the lira still faces an uphill struggle.

Companies and households bought up to US$2 billion of foreign currency following Thursday’s Central Bank of Turkey decision, said Istanbul-based currency traders, who declined to be named.

Those purchases, which capped gains in the lira, signal pent-up demand from local firms that have a net US$216 billion of foreign-currency liabilities.

On Thursday, the central bank raised its benchmark rate by 625 basis points in the biggest such increase in Turkish President Tayyip Erdogan’s 15-year rule.

The lira, which has lost more than 40 percent of its value against the US dollar this year, had firmed to as far as 6.08 against the US dollar following the rate hike, but later weakened slightly in early trade yesterday.

The currency pushed 0.7 percent higher against the dollar as of 9:37am to 6.0378.

The central bank’s hefty rate hike on Thursday meant that the bank had now increased interest rates by 11.25 percentage points since late April in an attempt to prop up the ailing lira, possibly easing investor concerns over Erdogan’s influence on monetary policy.

The bank’s decision came hours after Erdogan, a self-described “enemy of interest rates,” reiterated his opposition to high interest rates and blamed Turkey’s high inflation on the central bank’s wrong steps.

Key rates are now at their highest level since 2004, about a year after Erdogan first came to power.

The local foreign-exchange demand will add to a series of headwinds for the lira.

The dollar purchases came after Erdogan effectively barred Turkish entities from conducting business in dollars or euros on Thursday, a move that could be stoking anxiety among corporates.

Local investors have driven down their foreign-currency deposits this year to about US$150 billion as they snapped up cheaper lira.

Some analysts said that they are now likely to view any bouts of lira strength as an opportunity to rebuild their dollar coffers.

“There has been a trend of erosion in policymaking in Turkey,” said Inan Demir, a strategist at Nomura International PLC in London.

“Policies — monetary, fiscal, but also foreign policy — have been adding to the risk premium, not reducing it. It will be difficult to shake these memories off with one hike, even if it is a forceful and orthodox one, so I think it takes more than this to get the lira out of the woods,” Demir said.

While the bigger-than-expected rate hike could renew confidence in the central bank’s credibility, investors in the lira remain concerned about double-digit inflation and worsening relations with the US.